Berkshire Hathaway Looks Poised For New Highs (NYSE:BRK.B)

It’s a moment of truth for Berkshire Hathaway (NYSE:BRK.B) (BRK.A). As of Saturday, it is trading at $356, which is a mere $14 away from its all-time high, $370, set back in September. Although Berkshire Hathaway’s all-time high was set fairly recently, the stock has for the most part struggled to escape the $300 to $358 range, in which it has been trading for two years. Berkshire first hit $358 in March of 2022. Despite the brief flirtation with $370, a decisive breakout has been hard to come by for this stock.

Potentially, the company’s next earnings release could be the catalyst that takes things to the next level. This year we have a great setup for Berkshire to deliver solid fourth quarter earnings. Apple (AAPL) stock is flirting with all-time highs, Berkshire’s insurance business is booming, and the recent oil price crash provided attractive entry points in Occidental Petroleum (OXY) and Chevron (CVX). So we could see good things from Berkshire in the fourth quarter.

If Berkshire Hathaway beats earnings expectations once again in Q4, the stock could get moving in a big way. Berkshire is already at a reasonable price, inflation is coming down, and the Fed is holding rates steady. On top of that, the company beat on both revenue and earnings last quarter. Both the macro and the business factors look favorable to Berkshire right now.

For the fourth quarter, analysts expect Berkshire Hathaway to deliver $4.53 in adjusted earnings per share, which is down 9.3% from Q3. However, many factors will come together to boost Berkshire’s earnings for the quarter, including Apple being near an all-time high, Holiday shopping at See’s Candies, and an apparently favourable environment for insurance. M&A activity in insurance is up, premiums are up, and claims are at a reasonable level. All of these factors bode well for Berkshire’s insurance results in Q4. The railroad is likely to perform less well than in Q3, because cold weather tends to slow railroads’ operations down.

When I last covered Berkshire Hathaway, I rated the stock a buy because it was fresh off a strong fourth quarter earnings release and a major win in Japanese financial stocks. Today, the company has an even better setup. The economy is in great shape, and many of Berkshire’s subsidiaries will benefit from the Holiday spending no doubt currently underway. Although Berkshire has not put out any earnings releases since I last covered it, a number of macroeconomic data releases have come out, and they have mostly been very good. At the same time, Berkshire stock has risen only 1.3% since I covered it. The improved macro along with the largely unchanged stock price argue that Berkshire can be bought with more certainty today, compared to when I covered it last. We still have yet to see the company’s fourth quarter earnings-indeed, the quarter isn’t even over yet – but the improved macro makes a positive Q4 outcome more plausible than it was before. For this reason, I’m upgrading my Berkshire Hathaway rating to ‘strong buy.’

A Vastly Improved Macro Situation

Although it would seem appreciate sacrilege for a Berkshire Hathaway shareholder to include macro in his thesis, what with Buffett’s dim view of the topic, America’s macro picture has been very good. In the most recent quarter, U.S. GDP increased 5.2% year-over-year, while inflation declined to 5.2%. Talk about a one-two punch. When you’ve got growth rising and inflation coming down, you’ve got a formula for increased consumer spending. That’s good news for several Berkshire subsidiaries appreciate See’s Candy, Dairy Queen and equity-accounted Kraft Heinz (KHC).

Portfolio Stocks Rising

Another big advantage Berkshire has going in the fourth quarter is good performance in its equity portfolio. Buffett counsels people not to read too much into its stock portfolio performance, which is heavily influenced by speculation and other short-term oriented activities by market participants other than Berkshire. Nevertheless, it is nice to see a company you invest in doing well in its own stock market investments. Berkshire is definitely succeeding by this score. The following are the five largest holdings in Berkshire’s equity portfolio and how they’ve done this year:

Click to enlarge

A quick note on the methodology here:

The “contribution to returns earned by the top five stocks” columns treats the top five stocks as a portfolio in themselves. So, their weightings enhance compared to actual portfolio weightings. The result, treating the top five stocks as a portfolio is a 37.92% price return for the hypothetical portfolio. These five stocks’ actual contribution to Berkshire’s portfolio returns is smaller due to their smaller weighting in the total 60-stock portfolio. For example, Apple’s actual price return contribution to Berkshire’s marketable equities portfolio is 28%, rather than 37%. On the other hand, I did not factor in dividends to these calculations, so the total returns are much higher than what’s seen in the table above.

Valuation

Now, we can get into Berkshire’s valuation. This topic is tricky because Warren Buffett thinks his company’s performance should be evaluated with operating income instead of net income. Berkshire does have a massive stock portfolio, so yes, its GAAP performance is heavily influenced by non-cash factors. So, we need to compute a price/operating income multiple.

Berkshire’s operating income for the trailing 12-month period is shown below:

• Q3: $10.7B.

• Q2: $10B.

• Q1: $8.06B.

• Q4: $6.7B.

• TTM: $35.46B.

The company’s shares outstanding – A shares and B shares together – is equivalent to if the company had 2.17 billion B shares. So, we have $16.34 in operating income per share. So, with a $356 stock price, we get the following multiples (P/operating income calculated by author, the rest from Seeking Alpha Quant).

• Price/operating income: 21.78.

• Price/sales: 2.3.

• Price/book: 1.5.

• Price/operating cash flow: 17.3.

Overall, the stock is not “dirt cheap,” but it isn’t that expensive compared to the market either. The P/E ratio is about identical to that of the S&P 500, while the other multiples are lower. The stock’s $16.34 in operating income per share discounted at the treasury yield with no risk premium under a no-growth assumption gives a $408.5 fair value calculate. If you think that Buffett and his team of proven capital allocators will do no worse than 0% growth, then Berkshire Hathaway has at minimum 14.7% upside.

The Main Risk

The big risk with Berkshire Hathaway is of course succession. Warren Buffett is 93 years old, he won’t be around forever. Berkshire has put in place a team of world-class performers to take over from him: Greg Abel from Energy will be CEO, and Ajit Jain will keep running insurance. It will be interesting to see what happens with Berkshire’s stock portfolio after Buffett is gone. Neither Abel nor Jain is considered an ace stock picker. The company’s two money managers, Ted Weschler and Todd Coombs, are. Weschler’s Roth IRA has reached a value that implies it compounded at 30% CAGR for 30 years. Currently, Ted and Todd only supervise small portions of Berkshire’s portfolio. Perhaps they will be given larger responsibilities when Buffett is gone.

The succession risk mentioned here is mainly the risk of Berkshire not performing “spectacularly” after Buffett leaves. Buffett’s successors are world-class at their jobs, and Berkshire will likely be well run under their wings. In the meantime, Buffett is still in charge to some extent, and its equity portfolio has beaten the S&P 500 this year. I’d say there’s a decent chance we see Berkshire setting new highs in the next year or two.